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Government Policy to reduce

Relative Poverty
The tax and benefits system
Governments can intervene to promote equity, and reduce inequality and
poverty, through the tax and benefits system. This can be achieved by
employing a progressive tax and benefits system, which takes proportionately
more tax from those on higher levels of income, and redistributes welfare
benefits to those on lower incomes.
Stages of redistribution
Original income can be adjusted in a number of ways to either increase or
decrease post-tax income.

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Cash benefits
Cash benefits are designed to help those on low or zero original income, and
include contributory and non-contributory benefits.
Contributory benefits, such as, pensions and Job Seekers Allowance, are those
where individuals or employers make a contribution into the National
Insurance Fund.
Non-contributory (means tested) benefits, such as Housing Benefit, Income
Support and Carer's Benefit, do not require a previous contribution to have
been made. Child Benefit is not means tested and is a universal
benefit available to all families with children.
Direct taxes

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Income tax in the UK is mildly progressive and helps to redistribute income.
This is because:
1.

Individuals on low incomes pay no income tax. In 2014 the tax-free

'personal' allowance was 10,000.
2. Beyond this, income earners pay tax at the basic rate, which is currently
20%.
3. Those on higher incomes pay tax on some of their income at a higher
tax rate, which is 40%.
4. A higher rate of 45% for those earning over 150,000 of taxable income.
These tax bands help narrow the income gap and so help reduce inequality.
Indirect taxes
In contrast, indirect taxes are regressive meaning that, as a percentage of
income, the proportion of tax paid declines at higher income levels, and, as
such, the burden of the tax is largely on the poor. This means that, as a rule,
indirect taxes widen the income gap.
The progressive effects of direct tax, and regressive effects of indirect tax
generally cancel each other out.
Provision of services
The government provide services, such as healthcare and education that are
provided free or heavily discounted at the point of consumption. These
benefits can make a considerable impact on final income, increasing it
considerably for the poorest, and narrowing the gap between rich and poor.
Criticisms of progressive taxes and benefits
Taxes and benefits clearly compensate for the failure of labour markets to
provide sufficient original income for all citizens. However, such intervention
can be criticised because:
1.

It may create a disincentive effect, which occurs when individuals are

discouraged from working hard because they pay more of their income in
taxes.

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2.

Individuals may not look for ways to improve their own position because
the state provides insurance against poverty, unemployment, and
disability.

The National Minimum Wage

The long-term aim of a minimum wage is to remove the problem of poverty
pay, which exists when the earnings from paid work do not result in a living
wage and fail to push people out of poverty.
Other supply-side policies to reduce unemployment
Unemployment is a major cause of poverty and inequality. Unemployment can
be reduced by:
1.
2.
3.

Government sponsored job creation schemes.

A monetary or fiscal stimulus to aggregate demand.
Active labour market policies to increase employability, such as retraining schemes.
4. Welfare-to-work schemes, which encourage labour market participation.

Trickle Down Effect

Trickle down effect is a term used to describe the belief that if high-income
earners gain an increase in salary, then everyone in the economy will benefit
as their increased income and wealth filter through to all sections in society.
Trickle down effect and tax cuts
An important element of the trickle down effect is with regard to income tax
cuts for the rich. It is argued that cutting income tax for the rich will not just
benefit high-earners, but also everyone. The argument is as follows:
o

If high-income earners see an increase in disposable income, they will

increase their spending and this creates additional demand in the
economy. This higher level of aggregate demand creates jobs and higher
wages for all workers.

Alternatively, increased profits for firms may be reinvested. This again

leads to higher growth, wages and incomes for all.

Lower income taxes increase the incentive for people to work leading to
higher productivity and economic growth.

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Criticisms of the trickle down effect

o

o
o

High-income earners have a high marginal propensity to save. Therefore,

the increased disposable income from a tax cut does not filter into the
economy because it is saved not spent.
Higher levels of income and wealth inequality
To reduce relative poverty, it makes sense to target income tax cuts and
benefits at those who need it. Cutting taxes for the rich, in the hope some
may trickle down to the poorest may be inefficient.
Cutting taxes does not necessarily increase incentives to work.

Trade Unions
Trade unions use their collective bargaining power to protect their members
from employers. They can reduce relative poverty to an extent, but because
workers on low incomes are not usually part of a trade union the trade unions
power can be limited. Key roles of trade unions:
Protecting and improving the real living standards of their members
Protecting workers and upholding employment rights
Promoting improvements in working conditions, workload and health &
safety issues
o Workplace training and education
o Protection of pension rights for union members
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o
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